For bond traders, angst grows that this market dip is different

A little more than a week into the New Year, billionaire bond guru Bill Gross proclaimed the start of a bond bear market, after an extraordinary bullish run spanning more than three decades. Two weeks later, another billionaire, Ray Dalio of hedge fund firm Bridgewater Associates, piled on with a forecast of the worst bear market since the early 1980s.As yields on US Treasuries soared to levels unseen since 2014, Gross asked the question on many investors’ minds: Who would buy America’s debt right now? After all, the government deficit is soaring because of massive tax cuts, and the Federal Reserve is trimming its almost $4.4tn portfolio, which contains billions of dollars’ worth of bonds acquired in an effort to prop up the economy in the wake of the fiscal crisis.Yet many investors in the world’s biggest bond market are smiling. Traders were bored out of their minds for much of 2017, when Treasury yields fluctuated within the tightest range in a half-century. Long-term investors such as pension funds and insurance companies are also giddy at the prospect of a selloff in bonds that would push rates back up to the levels of yesteryear. During the years in which the Fed held interest rates near zero, safety-seeking long-term investors were forced to buy riskier assets to meet their return targets.“We needed this,” says Michael Franzese, head of fixed-income trading at MCAP LLC, a broker-dealer. “This market is not going to go up forever, and rates aren’t going to stay stable forever.” Franzese says the big question everyone is asking themselves is whether this is a blip or there’s something bigger at work: “A lot of people are sitting on cash and trying to decide what to do.”Since the 2008 financial crisis, buying when bond prices dipped usually led to quick profits, because central banks around the world stuck with ultralow rate regimes. Now there’s growing angst that this dip might be different.Those forces investors have counted on to continue keeping yields lower might not be so reliable anymore. The Fed, the largest single holder of US government debt, is allowing its debt holdings to slowly roll off. That means billions of dollars of demand is disappearing just as the Treasury plans bigger bond auctions, for the first time since 2009, to finance a growing deficit. The size of the Treasuries market is already $14.5tn (77% of gross domestic product), from $5.8tn at the end of 2008. What if America’s largest foreign bond customers, China and Japan, have had their fill? Indeed, they stopped increasing their holdings years ago.Speaking at a fixed-income conference in January, Bob Michele, head of global fixed income, currency, and commodities at JPMorgan Asset Management, said investors could “see a significant bear market.”No one really knows what a bond bear market would look like, largely because yields have been on a downtrend in the US for more than 30 years. There have been hiccups. A mass exodus from bond mutual funds like the one Michele envisions happened in 2013, in an episode dubbed “the taper tantrum.” Investors bailed out when Fed officials began talking about slowing their bond purchases. The 10-year yield hit 3% before falling back again. Still, that’s a long way from the double-digit interest rates of the early 1980s.Nothing points to bonds suffering a calamity such as the stock market experienced after Lehman Brothers’ 2008 collapse. (In a six-month span, the S&P 500 fell 45%.) Gross himself says the bond bear market will be a “mild” one. In the past 40 years, you can count on one hand the number of times (1994, 1999, 2009, and 2013) that Treasuries posted a negative annual total return (price change plus interest payments).The tricky thing about predicting a stampede out of bonds is that fixed income is, by definition, different from other asset classes. Treasuries are the closest thing out there to a risk-free asset because there’s an assumption that the US will never default on its obligations. Investors who ignore market fluctuations and hold their bonds to maturity will always get their money back, plus they collect interest along the way.